About this model Analytical models

Terminal values in d
DCF models typically include an explicit forecast of cash flo
represents a large proportion of the overall valuation. Con
are realistic, matters a lot. The most common terminal valu
exit multiple which is based on the observed multiples for
of both approaches. We explain these problems and show
This model illustrates five different ways to calculate a term
solution. However, the understanding of different approac
DCF valuations. The notes below provide a brief explanatio
terminal values click on 'About this model' to see the acco

Explicit cash flow forecast and present value

1 2
NOPAT 100 130

Depreciation and amortisation 60 70

Additional investment in fixed assets -75 -95
Change in net working capital -5 -7
Net increase in invested capital -20 -32

Enterprise free cash flow 80 98

Discount rate (WACC) 10.0%

Present value 438 73 81

Implied incremental ROIC 94%

Terminal value approach 1: Constant cash flow growth

Terminal value inputs Year 6 cash flow

Discount rate (from above) 10% NOPAT
Constant growth rate 3.0% Incremental investment
FCF year 6

Terminal value - Value of cash flows from year 6 2,398 Implied terminal EV/NOPAT mul

DCF valuation
PV of terminal value 1,489
PV explicit forecast cash flows 438
DCF enterprise value 1,928 Implied current EV/NOPAT multi

Sensitivity analysis Change in terminal growth r

Impact of changes in growth and discount -2% -1%
rate on DCF enterprise value
2% #VALUE! #VALUE!

Change in disc. rate

1% #VALUE! #VALUE!
0% #VALUE! #VALUE!
-1% #VALUE! #VALUE!
-2% #VALUE! #VALUE!

Terminal growth rate

1.0% 2.0%
Implied terminal incremental ROIC 7.0% 14.1%

Terminal value approach 2: Investment moderated constant cash flow growth

Terminal value inputs Year 6 cash flow

Discount rate (from above) 10% NOPAT
Constant growth rate 3.0% Implied incremental investment
Incremental ROIC 14.0% FCF year 6

Terminal value - Value of cash flows from year 6 2,197 Implied terminal EV/NOPAT mul

DCF valuation
PV of terminal value 1,364
PV explicit forecast cash flows 438
DCF enterprise value 1,802 Implied current EV/NOPAT multi

Sensitivity analysis Change in terminal growth r

Impact of changes in growth and discount -2% -1%
rate on DCF enterprise value
2% -26% #VALUE!
nge in disc. rate
 Change in disc. rate
1% #VALUE! #VALUE!
0% #VALUE! #VALUE!
-1% #VALUE! #VALUE!
-2% #VALUE! #VALUE!

Terminal value approach 3: Terminal exit multiple based on value drivers - single-stage m

Terminal value inputs

Discount rate (from above) 10%
Constant growth rate 3.0%
Incremental ROIC 14.0% Terminal EV/NOPAT multiple

Terminal value - Terminal multiple x year 6 NOPAT 2,197

DCF valuation
PV of terminal value 1,364
PV explicit forecast cash flows 438
DCF enterprise value 1,802 Implied current EV/NOPAT multi

Terminal value approach 4: Terminal exit multiple based on value drivers - two-stage met

Terminal value inputs Stage 1 Stage 2

Constant growth rate 7% 3.0%
Incremental ROIC 18.0% 14.0% Terminal EV/NOPAT multiple

Duration of period 1 growth 5 years

Discount rate (from above) 10%

Terminal value - Terminal multiple x year 6 NOPAT 2,522 Implied terminal multiple

DCF valuation
PV of terminal value 1,566
PV explicit forecast cash flows 438
DCF enterprise value 2,004 Implied current EV/NOPAT multi

Terminal value approach 5: Forward-priced comparable company multiples

Comparable company analysis Next 5 years average

 Current NOPAT
Current EV Year 1 NOPAT EV/NOPAT WACC FCF yield growth
Company 1 200 10 20.0x 10% 3% 20%
Company 2 400 14 28.6x 10% 5% 20%
Company 3 600 26 23.1x 10% 7% 20%
Company 4 800 42 19.0x 10% 9% 10%
Company 5 1,000 68 14.7x 10% 8% 5%
Company 6 1,200 75 16.0x 10% 6% 5%
Company 7 1,400 90 15.6x 10% 5% 5%
Company 8
Company 9
Company 10
Aggregate 5,600 325 17.2x
Median 19.0x
Mean 19.6x
Trimmed mean 18.7x Outliers to remove for trimmed mean
(Entering 1 removes one from each end of the distribution)

Terminal value inputs

Discount rate (from above) 10%
Exit multiple (median from table above) 12.7x
Year 6 NOPAT growth 3.0%

Terminal value - Terminal multiple x year 6 NOPAT 2,490 Implied terminal EV/NOPAT mul

DCF valuation
PV of terminal value 1,546
PV explicit forecast cash flows 438
DCF enterprise value 1,984 Implied current EV/NOPAT multi

This model is for general inform

© The Footnotes Analyst, 2023

 Articles About Subscribe

minal values in discounted cash flow - 5 approaches

an explicit forecast of cash flows for a certain period followed by a terminal value. Usually the terminal value
n of the overall valuation. Consequently, how the terminal value is calculated, and whether the assumptions used
he most common terminal value calculations we see in practice are either a constant cash flow growth model or an
on the observed multiples for comparable companies. However, there are problems with the practical application
ain these problems and show how they can be overcome in the alternatives below
fferent ways to calculate a terminal value. They are all interrelated and no one method provides the perfect
rstanding of different approaches, their assumptions and limitations, is important in order to successfully employ
low provide a brief explanation of each approach. For more detail about the model and further discussion about
ut this model' to see the accompanying Footnotes Analyst article.

3 4 5 For most DCF valuations the starting point is to prepare an explicit

150 170 190 and to discount this at a weighted average cost of capital. Alternati
unleveraged cost of equity, based on an asset beta, if an adjusted p
80 90 100 NOPAT (net operating profit after tax) is the commonly used term f
included in this must be consistent with the classification of assets
-106 -112 -118 or financing) in your forecasting model and in the bridge from DCF
-7 -8 -9 value. We recommend that NOPAT should be calculated before ded
that have been capitalised as a result of business combinations, if e
-33 -30 -27 replacement of these assets would not itself be capitalised.
Note: This is a simplified model intended for educational purposes only. Fo
117 140 163 account the timing of the valuation - the assumption is that the valuation
we used mid-year discounting. We have also omitted the enterprise to equ
only a target enterprise value and does not convert this into an implied ta

88 96 101

61% 67% 74%

ear 6 cash flow The simplest and perhaps most common terminal value calculation
196 cash flow at the end of the explicit forecast period grows in perpetu
value at the end of year 5 is calculated as:
Terminal value at year 5 = FCF in year 5 x (1
In addition to the terminal value and resulting DCF valuation, this s
that valuation to different inputs for growth and discount rate.
One of the problems with the constant FCF growth approach is tha
between NOPAT and FCF), implicit in the year 5 forecast, applies to
 The simplest and perhaps most common terminal value calculation
cash flow at the end of the explicit forecast period grows in perpetu
value at the end of year 5 is calculated as:
cremental investment -28 Terminal value at year 5 = FCF in year 5 x (1
168 In addition to the terminal value and resulting DCF valuation, this s
that valuation to different inputs for growth and discount rate.
One of the problems with the constant FCF growth approach is tha
mplied terminal EV/NOPAT multiple 13.0x between NOPAT and FCF), implicit in the year 5 forecast, applies to
linked to the input perpetual rate of growth. If, for example, the pe
model does not automatically adjust the level of investment, which
likely to make the terminal value appear to be more sensitive to ch
reality.
There is an implicit return assumption built into the selected growt
important that this is made clear when using this approach becaus
mplied current EV/NOPAT multiple 19.3x returns in the terminal period would likely indicate that the termin
shown the incremental return on capital that is implicit in the selec
changes for different growth rates.
Change in terminal growth rate You will also notice that in this calculation, and in the others below
enterprise value and the terminal value component in the form of i
0% 1% 2% provide a reality check on the assumptions used - it is much easier
#VALUE! #VALUE! #VALUE! multiples than it is the specific individual inputs for the full DCF mo
as EV/EBITDA, would also be useful.
#VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!

Terminal growth rate

3.0% 4.0% 5.0%
21.1% 28.1% 35.2%

flow growth

ear 6 cash flow One approach to ensuring that the level of investment in the termi
with the rate of growth, is to derive that investment separately and
196 simply grows at the long-term profit growth rate. Growth, reinvestm
plied incremental investment -42 in the following way:
154 Growth = Reinvestment rate x Incremental retur
The reinvestment rate is the net new investment divided by NOPAT
invested capital is the additional profit (i.e. NOPAT) derived from ad
Using this relationship, and with the addition of the incremental RO
mplied terminal EV/NOPAT multiple 11.2x investment in year 6 that is consistent with these inputs can be calc
When the long-term growth rate is flexed so too is the level of inve
value that is less variable for given changes in assumed growth, as c
sensitivity table with that above for approach 1.
Approach 2 will give precisely the same answer as approach 1 if the
in approach 2 is the same as the incremental return implied by the

mplied current EV/NOPAT multiple 18.0x

Change in terminal growth rate

0% 1% 2%
#VALUE! #VALUE! #VALUE!
 #VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!
#VALUE! #VALUE! #VALUE!

drivers - single-stage method

An alternative but equivalent to approach 2 is to use the terminal i

(g) and incremental return on invested capital (iROIC) to derive a te
calculation for this is:
Terminal NOPAT multiple = (iROIC - g) / [iRO
erminal EV/NOPAT multiple 11.2x The result is a first year prospective multiple. Applying the termina
year 5 terminal value to year 6 NOPAT. The implied terminal value i
Year 5 terminal value = Terminal multiple x Forecas
As long as the growth and return inputs for approaches 2 and 3 are
same terminal value.

mplied current EV/NOPAT multiple 18.0x

drivers - two-stage method

For some companies it may not be appropriate to assume that stea

and returns) apply from the end of the explicit forecast period. This
experiencing high growth or that are in an early stage of developm
erminal EV/NOPAT multiple 12.4x In this case adding an interim 'medium-term' growth phase can be
of ways, including extending the explicit forecast period itself. This
growth rate applied to FCF in this extended forecast or maybe a gro
assumed long-term rate.
The particular two-stage terminal value approach we show here is
At year 5 At year 10 approach above, except that the target year 5 EV/NOPAT multiple i
mplied terminal multiple 12.4x 11.2x differing growth and incremental returns.

To see the formula for this calculation and for more about target EV
'Linking value drivers and enterprise val

mplied current EV/NOPAT multiple 20.0x

multiples

Each of the above approaches use the direct input of long-term val
either directly or indirectly through the computation of a terminal
comparable companies as a basis for the terminal multiple. Implici
the market view about the same value drivers, albeit presented as
The objective of the comparable company analysis is to identify, fo
multiple it is likely to trade on (based on current expectations) at th
This not only requires that the companies you use must be truly co
 Each of the above approaches use the direct input of long-term val
either directly or indirectly through the computation of a terminal
Year 5 Forward comparable companies as a basis for the terminal multiple. Implici
Forward EV Year 6 NOPAT EV/NOPAT
the market view about the same value drivers, albeit presented as
281 25 11.3x The objective of the comparable company analysis is to identify, fo
511 35 14.7x multiple it is likely to trade on (based on current expectations) at th
This not only requires that the companies you use must be truly co
696 65 10.8x performance and future prospects, but, in addition, that the conditi
841 68 12.4x multiples are consistent with the conditions applicable to the value
period. It is for this reason that we prefer to use 'forward-priced' m
1,104 87 12.7x company based terminal multiple.
1,460 96 15.3x A forward-priced multiple is essentially the terminal multiple impli
value after taking into account the other components of an enterp
1,787 115 15.6x way to calculate such a multiple is illustrated in this table, where in
flow yield are used to calculate a forward EV and this is compared w
from an input growth assumption.

6,678 489 13.6x

12.7x For more about the alternative ways to calculate a forward priced m
13.2x be used see our article:
13.3x 'Why you should 'forward price' valuatio
1
end of the distribution)

mplied terminal EV/NOPAT multiple 12.7x

mplied current EV/NOPAT multiple 19.8x

This model is for general information and education purposes only - see terms of use and disclsimer
 Contact

is to prepare an explicit forecast of enterprise free cash flow

cost of capital. Alternatively, the discounting may be at an
set beta, if an adjusted present value approach is applied.
e commonly used term for a post-tax operating profit. What is
e classification of assets and liabilities (as operating, investing
d in the bridge from DCF enterprise value to target equity
be calculated before deducting amortisation of intangibles
siness combinations, if expenditure related to the
lf be capitalised.
ucational purposes only. For example, we have not tried to take into
mption is that the valuation date is the beginning of year 1. Nor have
mitted the enterprise to equity bridge and hence the model produces
vert this into an implied target stock price.

erminal value calculation is to assume that the enterprise free

t period grows in perpetuity at a constant rate. The terminal

ear 5 = FCF in year 5 x (1 + g) / (WACC- g)

ting DCF valuation, this section also shows the sensitivity of
h and discount rate.
growth approach is that the reinvestment rate (the difference
ear 5 forecast, applies to all subsequent periods and is not
erminal value calculation is to assume that the enterprise free
t period grows in perpetuity at a constant rate. The terminal

ear 5 = FCF in year 5 x (1 + g) / (WACC- g)

ting DCF valuation, this section also shows the sensitivity of
h and discount rate.
growth approach is that the reinvestment rate (the difference
ear 5 forecast, applies to all subsequent periods and is not
h. If, for example, the perpetual growth rate is flexed then the
vel of investment, which is almost certainly unrealistic. This is
be more sensitive to changes in growth rate than it may be in

t into the selected growth rate and the year 5 investment. It is

ng this approach because an unrealistic value for incremental
indicate that the terminal value itself is unrealistic. We have
hat is implicit in the selected model inputs and how that return

and in the others below, we have expressed both the DCF

mponent in the form of implied EV/NOPAT multiples. This is to
used - it is much easier to make judgements about valuation
nputs for the full DCF model. In practice, other multiples, such

investment in the terminal period is realistic, and consistent

vestment separately and not assume that the year 5 amount
h rate. Growth, reinvestment and return on capital are linked

rate x Incremental return on invested capital

tment divided by NOPAT and the incremental return on
NOPAT) derived from additional investment.
on of the incremental ROIC as a model input, then the
these inputs can be calculated.
o too is the level of investment. The result of this is a terminal
s in assumed growth, as can be seen by comparing the
ach 1.
swer as approach 1 if the explicit input for incremental returns
tal return implied by the investment in approach 1.
2 is to use the terminal inputs of discount rate (WACC), growth
ital (iROIC) to derive a terminal EV/NOPAT multiple. The

ltiple = (iROIC - g) / [iROIC x (WACC - g)]

le. Applying the terminal value inputs produces the multiple of
implied terminal value is therefore:
minal multiple x Forecast year 5 NOPAT x (1 + g)
r approaches 2 and 3 are the same, each will produce the

riate to assume that steady state conditions (constant growth

plicit forecast period. This particularly applies to those
early stage of development.
m' growth phase can be useful. This can be done in a number
recast period itself. This period may have a medium-term
d forecast or maybe a growth rate that fades gradually to the

proach we show here is the same as the terminal exit multiple

ar 5 EV/NOPAT multiple is derived using two stages, with

for more about target EV multiples see our article:

rivers and enterprise value multiples'

ct input of long-term value drivers to derive a terminal value,

mputation of a terminal multiple. An alternative is to use
erminal multiple. Implicit in the comparable company data is
vers, albeit presented as a single number.
analysis is to identify, for the company you are valuing, what
urrent expectations) at the end of the explicit forecast period.
you use must be truly comparable in term of business
 ct input of long-term value drivers to derive a terminal value,
mputation of a terminal multiple. An alternative is to use
erminal multiple. Implicit in the comparable company data is
vers, albeit presented as a single number.
analysis is to identify, for the company you are valuing, what
urrent expectations) at the end of the explicit forecast period.
you use must be truly comparable in term of business
addition, that the conditions reflected in the comparable
ns applicable to the valued company at the start of the terminal
o use 'forward-priced' multiples to derive a comparable

e terminal multiple implied by the current market enterprise

omponents of an enterprise FCF DCF valuation. The easiest
ed in this table, where inputs of cost of capital and free cash
EV and this is compared with a year 6 NOPAT which is derived

culate a forward priced multiple and how such multiples can

d 'forward price' valuation multiples'

Terms of use and disclaimer

Workings for sensitivity table
Constant growth rate

Terminal value
PV explicit forecast cash flows
DCF enterprise value

Sensitivity table 1,928

2%
1%
0%
-1%
-2%

Workings for sensitivity table

Constant growth rate

Incremental ROIC

Terminal value
PV explicit forecast cash flows
DCF enterprise value

Sensitivity table 1,802

2%
1%
0%
-1%
-2%
3.0%

1,489 Disc. rate sensitivity 0.0%

438 Growth sensitivity 0.0%
1,928

-2% -1% 0% 1% 2%

3.0% NOPAT 195.70

14.0% Implied incremental investment -41.94

FCF year 6 153.76

1,364 Disc. rate sensitivity 0%

438 Growth sensitivity 0%
1,802

-2% -1% 0% 1% 2%